New funding opportunities in the oil and gas sector

In a recent report, EY outlines changing trends in oil and gas financing, focusing on the funding options that are currently available to firms in the industry.

Project finance

Project finance has been less widely used in the oil and gas sector than in other sectors such as power and utilities. Future revenue streams are typically less stable in oil and gas. The logistics, infrastructure and social issues caused by the increased size of projects have made achieving time, cost and quality targets more challenging than ever. According to EY, the industry’s relatively poor track record of completing projects on time and on budget will test banking sector appetite for lending to the oil and gas sector.

Project financing has typically been more prevalent in the downstream sector than in the more capital intensive upstream sector. In 2013, the Sadara Chemical Company JV successfully completed the project financing for the Sadara chemical complex in Saudi Arabia. The total raised was approximately US$ 12.5 billion, which represented the largest ever project financing in the Middle East.

Some of the proposed LNG projects in the US have also been successful in attracting project financing from multiple lenders. These projects typically provide lower construction risk and fewer delays to the completion schedule.

Corporate and project finance considerations

EY explains that local content requirements can also make arranging project finance for some oil and gas projects more challenging. Oil companies may need to assist weaker local partners to raise their share of funding and be a lender on the same terms as the banks.

Credit enhancement can enable increased support for long-term investment in challenging markets. Export credit agencies (ECAs) have stepped up to supplement the banking sector in an effort to support local firms, with many now offering working capital cover to banks and introducing or expanding securitization guaranteed products. The International Finance Corporation (IFC) supports private investment in the oil, gas, and mining sector, to help developing countries realise the benefits from their natural resources and to ensure that local communities enjoy tangible benefits.

According to EY, ECAs and development finance institutions are increasingly providing support for larger transactions. They are becoming more flexible and commercial and are prepared to work alongside commercial banks.

Infrastructure investment

EY highlights growing interest among investment funds in infrastructure as an asset class. Infrastructure investment remains a core objective for many governments as a means of stimulating economic growth.

The majority of institutional investors in infrastructure debt are public pension funds, insurance companies and private sector pension funds. The long-term natural of most oil and gas projects might provide a match to the long-term liabilities of insurance companies and pension funds. However, EU Solvency II requirements could limit European insurers’ ability to continue providing long-term funding. Insurers are faced with the challenge of balancing a desire for greater returns against compliance with new regulations.

An obstacle to direct pension fund involvement in infrastructure projects has traditionally been their lack of understanding of the industry and their inability to evaluate and monitor such projects. Compred to infrastructure projects that provide more predictable future cashflows, upstream oil and gas projects may be considered higher risk. In other industries, banks are looking to invest during the construction period of long-term projects with a predefined exit at the end of construction. Insurers are perhaps more likely to invest after the development and construction phases because they have traditionally had a limited appetite for construction risk, according to EY.

Looking forward

The EY report concludes with the assertion that opportunities exist to optimise financing to increase both its availability and reduce its cost. In many instances these opportunities are supported by an appropriately priced supply of finance via existing mechanisms and providers.

In other areas there is potential to obtain material financing from newer sources but currently there are structural issues preventing this from happening. These usually relate to the inability of potential finance providers to lay off critical risks. There is therefore scope for providers of risk management services to facilitate the growth of this market.